Just like what Mark Cuban said, no matter what business you're in, you've got to know your customer acquisition cost (CAC). This is a crucial component of growing a business and, without it, you won’t get far. Trying to increase your customer base and profit margins without knowing your CAC is like flying a plane blind. You’re lost among the clouds without any instruments to guide you.
How can we possibly know which direction to head in to find a safe landing spot?
Companies that don’t know how much they are and should be spending to acquire new customers can only make decisions based on emotions. These kinds of decisions are bound to be bad ones.
With that in mind, you might want to ask yourself these questions:
- How can you lower your CAC? 📉
- And is the goal to lower CAC?
- Might it be to maximize it? 🤯
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First of all, you need to know how to calculate it, using the help of Customer Lifetime Value (LTV). Next, you need to decide whether to pursue a strategy based on ads or SEO and then make decisions on profitability of your marketing campaigns (and whether to continue each).
Here’s all you need to know to make that decision.
Customer Acquisition Cost Formula: How Does One Calculate CAC & What Costs to Include/Exclude?
There’s a relatively simple formula you can use to calculate your CAC: You take all the costs you’ve spent acquiring new customers and divide it by the number of new customers.
Of course, this leads to further questions, including what costs should be included and the time frame being analyzed. These are questions that businesses will need to decide for themselves.
- Generally speaking, the costs included in acquiring new customers involve the costs of marketing and sales. How much has been spent on ad campaigns? What about hiring and training marketing staff? SEO and ads are the main costs to factor in here. It’s important to go through all of your business expenses determining what counts as marketing and sales and what does not.
Once you’ve decided this, the calculation isn’t too hard.
Say you want to calculate your CAC over the last financial year.
If all your marketing and sales costs add up to $10,000 and you’ve acquired 5000 new customers, then you simply workout 10,000 divided by 5,000. That equals 2, meaning that your CAC is $2. That means that every new customer has cost the business $2 to acquire.
While these numbers are useful and interesting information, how do you evaluate them?
You need to figure out what a good CAC is for your company and set targets for the future. Then, run the calculation again and see if you hit your goals.
What is a Good Customer Acquisition Cost?
Every company has its own goals. What’s good for one may be bad for another. While it would seem that the lower the CAC, the better, this is not always true.
“He who can spend the most to acquire a customer, wins.”
Wait, what did you just say? 🤬
No, I didn’t misspeak…
Especially in the beginning, you have to spend money to attract new customers. And if you know how much you can make from a new customer relationship over time, you can afford to lose $ in the short term since:
- Make up the sales/profit in the long term
- Run competitors out of business (or lessen their growth) because they can’t spend as much as you can to acquire a customer.
- Build customer loyalty
While you’ll want to continually grow your business, it should happen sustainably and at a reasonable cost. If you’re spending more than you can make back in a few years, then this isn’t sustainable.
Benchmarks for CAC vary across industries. You should think about the value of each customer. Are they making a small one-off purchase or are they going to be here for a lifetime, spending vast sums on a regular basis?
For instance, high-value industries can be $1,000s to $100,000s, especially in the B2B realm, and some in the B2C arena can be a few dollars to $10,000s as well. Research your own industry and find out what the CACs of the most successful companies are.
How Customer Lifetime Value (LTV) Impacts Customer Acquisition Cost
One main factor in determining your CAC targets is Customer Lifetime Value (LTV). LTV is the net value of a customer to your business (over time).
- This can be calculated by adding up the total amount of money your customer spends during their entire relationship with your company (not just their first order).
- Then, subtract the costs you spend creating the products or services they buy. Simply put: LTV is the profit generated on each customer.
This is crucial for figuring out your CAC. The higher your LTV, the more you can afford to spend on acquiring each customer. If a customer is only going to generate your company a profit of $10, then it obviously doesn’t make sense to spend $100 attracting them. If however, they’ll generate a profit for the business of $10,000, then it’s well worth spending a couple of grand to get them on board (even though you lose $ in the short term).
With that in mind, calculate your company’s LTV before trying to set CAC targets. Once you’ve got your head around these two calculations, you’ll be able to set out a strong marketing strategy and will know exactly how much to budget to make it happen. What, then, is the best strategy for yielding a lower CAC?
CAC: The Ads vs. SEO Showdown
When it comes to CAC, you can either invest more in paid ads or spend more time on SEO. So which wins out?
Both methods have pros and cons. When making marketing & sales decisions, you need to decide which option is best for your situation. Of course, you’ll want to use a mixture of both. However, you can use the chart below to decide whether to lean more towards ads or SEO.
The main reason for opting for paid ads is that it’s a quick way to generate leads and sales today (or very soon). It guarantees your business will be seen by a wider audience NOW.
Ads put your content at the top of Google search results, social media news feeds or other platforms. If you’re relying on SEO alone (which takes time to show results), then you can’t guarantee this kind of reach immediately. At least, it’ll take a long time for your products to enter the consciousness of potential customers.
However, don’t discount SEO completely.
It is a more sustainable strategy because you’ve gained the trust of customers via SEO-fueled content/inbound marketing. As a result, they’ll likely be more loyal and spend more money on your products over a longer period. Although SEO costs more to begin with, it’s cheaper in the long term.
After 12-18 months, you’ll find that paid ads have a more expensive CAC compared to SEO when you spread that initial SEO expenditure over a 3-5 years horizon that you will get your ROI from.
So, Which One is the Winner?
There’s a definitive answer to this question, but that is “it depends”. Bottom line is:
- Invest in ads in the short-term to drive leads/sales today
- BUT…don’t forget to start SEO because it takes 12+ months to yield fruit but it will outpace ads in 18-24 months. And the longer you delay this step, the longer it will take to get results.
Make sure you know your CAC & LTV numbers. Once you’ve done that, you stop being a blind pilot and start relying on the data to guide you in the right direction.
Over time, you’ll see how investing in either ads or SEO can hit your CAC targets so you can sustainably grow your company + put a few of your competitors out of business in the process.